Why You Shouldn’t Bet Against Buffett

Four years ago, Berkshire Hathaway (NYSE:BRK) chairman Warren Buffett wagered asset management firm Protégé Partners that an S&P 500 index fund would outdo the average return of portfolio of funds of hedge funds picked by his opponents. The friendly competition, which started on January 1, 2008, and ends on December 31, 2017, will award $1 million to a charity of the winner’s choosing.

“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses,” the exact bet reads.

Buffett’s chosen VanguardAdmiral shares lost in the first year, but won in the second and third years, and the results for 2011, reported by Fortune, say Buffett is on his way to overhauling the combined portfolio. Buffett’s chosen fund gained 2.08 percent in 2011 to beat the five hedge funds portfolio, which fell 1.86 percent. Through the last four years, the hedge funds have declined 5.89 percent, while Buffett’s index fund is close to closing the gap, as it is now down 6.27 percent.

Vanguard Admiral shares have gained 2.2 percent from the start of the bet through February 29, while the hedge funds have fallen a total of 4.5 percent since then.

Funds of funds have been seeing declines as public pension funds start investing in hedge funds directly. Funds of funds now only control $630 billion compared to $780 billion four years ago.

Buffett says funds of funds cost too much because they add extra fees even over hedge funds. Protégé’s point is that hedge funds have the advantage of betting on rising as well as falling prices of stocks, bonds, currencies, and commodities, thus having a better chance of outdoing the S&P index.

A mutual fund of funds manager told Bloomberg that the right application was necessary for performance in his kind of investment. “Hedge funds of funds have underperformed because of high fees and mediocre manager selection,” said Brad Alford, head of Alpha Capital Management. His strategy has posted an annual average return of 8.2 percent since 2009.

To contact the reporter on this story: Aabha Rathee at staff.writers@wallstcheatsheet.com

To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com